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Chapter 17

Question 13

Cost of redeemable debt

Bishop Co has in issue 6% redeemable debt with 6 years to redemption.
Redemption will be at par. The current market value of the debt is $92.96. The
rate of corporation tax is 30%.

Calculate the return required by debt holders (pre-tax cost of debt).

Then calculate the cost of debt to the company (post-tax cost of debt).

Return required by debt holders (use pre-tax interest value)

Time cash flow d.f/a.f 5% PV d.f/a.f 10% PV

t0 £(92.96) 1 $(92.96) 1 $(92.96)

t1-6 $6 5.076 $30.46 4.355 $26.13

t6 $100 0.746 $74.60 0.564 $56.40

NPV $12.10 NPV $(10.43)

IRR = 5 + [$12.10/($12.10 – $(10.43))] × (10 – 5)

IRR = 5 + 0.537 × 5 = 7.7%

Cost of debt to the company (use post-tax interest value)

Time cash flow d.f/a.f 5% PV d.f/a.f 10% PV

t0 £(92.96) 1 $(92.96) 1 $(92.96)

t1-6 $4.20 5.076 $21.32 4.355 $18.29

t6 $100 0.746 $74.60 0.564 $56.40

NPV $2.96 NPV $(18.27)

IRR = 5 + [$2.96/($2.96 – $(18.27))] × (10 – 5)

IRR = 5 + 0.139 × 5 = 5.7%

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